Two years of US financial reform paves way out of financial crisis

The US Congress passed a landmark reform, known as the Dodd-Frank Wall Street Reform and Consumer Protection Act, on July 21, 2010, to prevent the financial sector from repeating the 2008 crisis.

Two years later, with the support of Dodd-Frank, analtysts say US financial markets are stronger than they were before the crisis, and the US public can count on better consumer finance protection while dealing with financial services institutions.

Consumers have a watchdog

Perhaps the most notable result of the Dodd-Frank Act is the establishment of the Consumer Financial Protection Bureau (CFPB).

The agency aims to protect consumers from confusing, and sometimes deceptive, financial products and lending practices like the ones in mortgage scandals, according to the Center for American Progress, a public policy research organization.

Prior to its creation, the authority to write and implement rules for protecting consumers was dispersed between states and several different federal agencies. Often, consumer protection was not a relatively high priority for regulators charged with monitoring large banks and major markets.

Especially since the appointment of Richard Cordray as head of the bureau early this year, the CFPB finally can assume its full rule-making and supervisory authority.

On June 18, the new consumer protection agency announced its first public enforcement action with an order requiring Capital One Financial Corp. to refund about 140 million US dollars to 2 million customers and pay an additional 25-million-dollar penalty for pressuring or misleading consumers into paying for "add-on products" such as payment protection and credit monitoring when they activated their credit cards.

"We are putting companies on notice that these deceptive practices are against the law and will not be tolerated," Cordray said.

Systemically important firms under severe oversight

One of the biggest contributing factors to the 2008 financial crisis was that the activities of many non-bank financial institutions, those without a full banking license or not supervised by a national or international regulatory agency, went largely unchecked.

After the collapse of large non-banks such as American International Group and Lehman Brothers, Dodd-Frank created the Financial Stability Oversight Council (FSOC) to identify systemically important financial institutions (SIFIs).

Under the final rule the FSOC issued in April 2012, non-bank financial institutions will be designated "systemically important" if they have total assets of more than 50 billion dollars and meet one of five thresholds relating to credit default swaps, outstanding debt, derivatives, leverage ratio and short-term debt.

In July 2012, the council designated eight financial clearing houses as systemically important.

SIFIs are subject to centralized regulatory oversight by the Federal Reserve. The Fed sets out and implements rules including debt limits, core tier one capital ratio and restrictions from certain types of risky activities.

The Fed can also impose additional capital requirements on SIFIs, which proved to be a viable way to deleverage portfolio and enhance capital buffers for financial distress.

When Lehman Brothers failed, it had one dollar in equity for every 30 dollars it was borrowing.

Dodd-Frank also mandated the Fed to carry out annual stress tests on all banks with 50 billion dollars or more to determine if they have the capital needed to absorb losses under crisis scenarios.

The latest test results in March 2012 showed that 15 of the 19 largest financial firms operating in the United States had enough capital to withstand a severe recession. The 2009 test found 10 of the banks had insufficient capital to withstand a crisis.

"Thanks in part to progress on financial reform, the US financial system is stronger and better able to absorb shocks than was the case even a year ago," the FSOC said in a report days ago.

Tons of threats lie ahead

It is important to know that the two years of efforts are simply the first step in a process of shoring up the financial system. With tremendous technical and political headwinds, the Dodd-Frank Act still has a tough war to fight in the years ahead.

For example, regulators need to finalize many rules with technical details to make markets safer, keep companies competitive and protect US consumers.

Meanwhile, "police officers" of the financial sector have to head-butt against opponents who keep seeking to weaken and delay key measures so as to discard progress made so far.

Groups of Republicans both in the House and the Senate are always ready to take chance to roll back the prescription made by Dodd-Frank. From the moment it was signed into law, Wall Street lobbyists have fought regulators over every line in the rule-making process.

To make it worse, scandals after scandals keep popping up. Not surprisingly, headlines like JPMorgan Chase's sudden trading loss and Barclays' rigging on Libor and Euribor rates will not become extinct for good.

"Threats to financial stability are always present even if they are not always easy to discern in advance," said the FSOC.

US President Barack Obama has called the Dodd-Frank Act "the strongest consumer financial protections in history." After all, the 2,300-page act dealt a major blow to the extravagant financial corruption that caused the global financial crash in 2008.